At 65 years old, Mike and Patty from Lehi were reaching retirement age and were in a good position.
Mike had worked for 20-plus years for a local Salt Lake City company. Patty was a stay-at-home mom and later became a substitute teacher.
They owned their home. They didn’t have any debt to speak of. Their kids were launched and were happy, healthy, and independent.
They had a generous fund of rainy day savings, and had put away roughly $500,000 in tax-deferred IRAs.
They wanted to keep their retirement accounts growing – while paying as little in taxes as possible. So Mike and Patty planned to use some of their savings plus their income from Social Security to cover their retirement expenses for the next few years. When they turned 73 years old, they planned to start taking Required Minimum Distributions from their IRAs.
In short, they had done everything right. Or had they?
Mike and Patty’s story isn’t unique. Like many other hard-working Americans, they used tax-deferred IRAs and 401Ks to avoid paying taxes while saving for retirement. This is widely-recommended by CPAs and tax accountants. In part, because it lets you reduce your taxes owed each year, while they’re helping you file your taxes.
But Mike and Patty were quite shocked when they realized what they had done by following this so-called “best practice” of delaying their taxes.
They had placed what some financial planners call a tax time bomb right in the middle of their retirement. And their current plan was only set to make it worse – but they didn’t know that, yet.
Mike and Patty had seen B.O.S.S. Retirement Solutions on KSL TV. They’d also heard the show on the radio. And even though they were pretty confident in their plan for retirement, they decided to reach out.
They figured it wouldn’t hurt to get a second opinion on their plan
Especially because B.O.S.S. offers a free, custom Retirement Tax-Savings Analysis.
A fiduciary advisor from the B.O.S.S. Retirement Solutions team took Mike and Patty through their standard process. This process is designed to show you how much money you would be paying in taxes when you’re retired – as well as any opportunities to reduce these taxes.
Mike and Patty shared some basic information about what money they had, in which accounts, as well as their retirement plans. They also explained how they planned to use that money in retirement.
The advisor calculated an estimate of how much Mike and Patty would owe in taxes on their retirement savings – including that $500,000 in their tax-deferred IRAs.
Mike and Patty were stunned at the tax projection
Unfortunately, a lot of people underestimate what they’ll owe in taxes on their IRAs and 401Ks in retirement.
It’s easy to look at a $500,000 account, assume a 25% tax rate, and calculate that you’ll pay $125,000 in taxes. But it really doesn’t work this way.
Because you don’t just pay taxes based on today’s value. You only pay taxes on the money you withdraw from your IRA or 401K.
If your account value grows – as you hope it would – your future tax obligations grow, too.
Mike and Patty didn’t plan to start taking the money out of their tax-deferred plans until age 73. Assuming a conservative 5% growth rate, that money would be worth nearly $750,000 before they withdrew the first dime.
This sounds great until you realize Mike and Patty would also owe taxes on the extra $250,000. Plus, they only planned to withdraw a portion each year, so the account would continue to grow – along with the amount of taxes they would owe.
All in, Mike and Patty were on course to pay an estimated $187,428 in taxes just on the Required Minimum Distributions from their IRA – up through age 90.
If they reinvested those withdrawals, they could expect to pay another $62,958 in taxes on that money.
And to top it all off, their children could be hit with a massive $167,181 tax bill on what would be left in the account after Mike and Patty were gone.